Jason Stipp: I'm Jason Stipp for Morningstar. During the depths of the economic downturn, Morningstar's Bob Johnson was able to see some glimmers of hope, when other folks only saw despair. But now that some folks' expectations for the economy are heating up, Bob is seeing some yellow flags out there that should be on your radar. He's here with me to explain.

Thanks for joining me, Bob.

Bob Johnson: Great to be here.

Stipp: So, your yellow flags, your concerns over the economy right now are all related to the consumer because now is the consumer's time to shine; we've talked about this before. The first one has to do with what the consumer is taking home in the paycheck.

Johnson: Yes.

Stipp: Can you explain a little bit about what the situation is?

Johnson: Yes. What I really like to look as a good forward indicator is the real hourly wage. It is one of the most sensitive metrics that moves before employment or a lot of other indicators do, and that real wage number is what you get paid in nominal terms--what your check actually is each hour that you work--and then compare that to what inflation is.

Stipp: So, what are we seeing on the nominal front. We know that companies have squeezed a lot more efficiency out of their workers. Have they seen that reflected in their paychecks at all in nominal terms really?

Johnson: The nominal numbers are relatively flat and really have been for a fairly long period of time.

Stipp: So, this kind of leads to a second question then, it's something that we've discussed before. Inflation has been pretty tame, so although you haven't been getting a raise from your employer, over the last year or so, you also haven't seen your costs necessarily increase and in some cases, they might have gone down, correct?

Johnson: Yes, you actually got a de facto raise in some portions of 2009, because there was actually deflation and everybody's checks stayed about the same. So, that was a really big help. It was one of the signals that we might come out if this recession; it came early on, when almost nothing else did.

Stipp: So, the problem now, though, is a yellow flag has gone up after we saw the recent inflation report, and we're also just seeing day-to-day what we're paying for things such as gas.

Johnson: You've got a series of categories that are starting to look a little risky. Oil prices are up, and that affects a broad range of things, but the main thing that we see is gasoline prices, which are difficult to evade, frankly.

Stipp: And also we're seeing some food inflation creeping in as well?

Johnson: Food is another category--and frankly it hasn't really turned up in the Consumer Price Index, yet. It was a small portion of last month's near record increase in the CPI number that we saw--last month it was energy. But I think food prices are yet to come, and we've got things like corn et cetera going up, because of crop failures around the world.

Stipp: So, digging into why this is a concern, why this is a yellow flag. What's the effect of these rising prices on consumers, because we did see some savings rates go up during the downturn, so do consumers have a little bit of flexibility to pay some of this inflation if they need to?

Johnson: One of the interesting things to look at is to split the population in two ways, and this is from the Survey of Consumer Finance. So, it's a government financed survey, and it shows that roughly two-thirds of all households make less than $70,000 a year, and on average they spend every dime that they get.

The closer you get to the $70,000 as you move up the income scale, the more the savings is. But if just want to cut it simply, the people with $70,000 or less really don't save any money. So, if the price of gasoline or something goes up, they haven't got lot of places to turn.

Stipp: So they're really living paycheck to paycheck. If they were going to spend on something else they can't now because they have to fill that gas tank?

Johnson: Absolutely.

Stipp: So, if one yellow flag is that nominal wages are stagnant. A second one is that costs are going up. The third one you mentioned to me is the issues that we're seeing with the state and local governments and how that might play out in your tax bill.

Johnson: The state and local governments, it's a very interesting situation--to meet the budget gaps that some of the states are now seeing, we're seeing some record tax increases. Here in Illinois we've seen a tremendous increase in our tax rate, enough to offset some of the federal benefits that we will hope to collect.

But it goes beyond that to the goods and services that the government offers: the tax collections, the pool memberships, all the things, the government services that they provide. Those are going to be all fair game for raising fees in the year ahead.

And we've seen that already. We've talked on the Consumer Price Index videos [that] one of the leading categories [has been] anything that happens to be government-related, whether it's water or whether it's schools, [it tends] to be increasing.

Stipp: So, if the consumer's wallet potentially will be under some pressure, what do you need to see? What could counteract this? What might lower some of these yellow flags in the near term?

Johnson: Why I am at yellow and not red. Again these type of metrics that we're talking about tend to be the long lead time indicators. You tend to have four to nine months to react. So that's the good news: we've got a little bit of time to react.

Now what we need to see offset it: it's kind of like with the weightlifter. You need to increase the amount of the work you do, whether you do more repetitions, whether you add more weight or actually whether you do more sets; any one of them will get you stronger, and you don't need to do all of them better at the same time.

It's the same way on the consumer wage front. You can either have hourly wages going up, you can have the number of employees going up, or you can have the number of hours worked going up. And I don't need all three of those going in one direction. Last few months, we've talked about the hours worked has gone up, and that's been a key driver, while employment has gotten a little better. So, now as we go through months ahead, maybe we will see some increase in the employment that will offset some of the real wage issue that we're seeing.

Stipp: Do you have some reason for optimism on that front why we might see one of those things go up?

Johnson: Well, November and December are a real hard time to really talk about employment and wages very much, because who wants to really hire somebody ... when you will have to pay him for the Thanksgiving holiday and New Year's holiday and a Christmas holiday, all kind of wrapped into one. Why not just wait until the first of the year? Those are kind of slow times of the year anyway, so you tend to see a big jump up at the first of the year and the same with hours and so forth that complicate things. You just don't see the big jumps in November and December.

So, that's why when I'll look to the numbers in January to see if those finally get turning back in the right direction again. I'm hopeful. There are anecdotal stories out there. I know of at least two businesses [where] the first Monday of the New Year when all the new employees showed up, frankly the Human Resources department couldn't really handle the volume of people. They've been so used to taking one at a time that just even getting people computers and telephones suddenly became a big issue.

Stipp: Something they hadn't maybe done for quite a while?

Johnson: Right.

Stipp: Well, Bob, hopefully we'll see some of those yellow flags turn to green, but I'll look forward to checking in on that data when it comes in. Thank you for joining me today.